Derivative Instruments and Hedging Activities

The Company enters into derivative instruments in connection with its risk management activities. These derivative instruments include interest rate swaps, swaptions and futures. The Company may also purchase or sell short TBAs, purchase put or call options on U.S. Treasury futures or invest in other types of mortgage derivative securities.

Derivatives Not Designated as Hedging Instruments

The following table presents the fair value of derivative instruments that were not designated as hedging instruments and their location in our condensed consolidated balance sheets at September 30, 2017 and December 31, 2016, respectively (dollar amounts in thousands):



Derivatives Not Designated as Hedging Instruments	Balance Sheet Location	September 30, 2017		December 31, 2016
Eurodollar futures	Derivative assets	$	289	$	1,175
TBA securities	Derivative assets	180,562		148,139
Interest rate swap futures	Derivative assets	1,228		444
Swaptions	Derivative assets	18		431
U.S. Treasury futures	Derivative liabilities	193		107
Interest rate swaps ⁽¹⁾	Derivative liabilities	274		384


⁽¹⁾	Includes interest rate swaps in our Agency IO portfolio. There was no netting of interest rate swaps at September 30, 2017 and December 31, 2016.

The tables below summarize the activity of derivative instruments not designated as hedges for the nine months ended September 30, 2017 and 2016, respectively (dollar amounts in thousands):



	Notional Amount For the Nine Months Ended September 30, 2017
Derivatives Not Designated as Hedging Instruments	December 31, 2016			Additions		Settlement, Expiration or Exercise			September 30, 2017
TBA securities	$	149,000		$	1,466,000	$	(1,440,000	)	$	175,000
U.S. Treasury futures	17,100			123,900		(135,500		)	5,500
Interest rate swap futures	(151,700		)	413,800		(349,000		)	(86,900		)
Eurodollar futures	(2,575,000		)	5,989,000		(5,054,000		)	(1,640,000		)
Options on U.S. Treasury futures	—			5,000		(5,000		)	—
Swaptions	154,000			—		—			154,000
Interest rate swaps	15,000			—		—			15,000



	Notional Amount For the Nine Months Ended September 30, 2016
Derivatives Not Designated as Hedging Instruments	December 31, 2015			Additions		Settlement, Expiration or Exercise			September 30, 2016
TBA securities	$	222,000		$	2,925,000	$	(2,866,000	)	$	281,000
U.S. Treasury futures	—			189,800		(146,400		)	43,400
Interest rate swap futures	(137,200		)	718,700		(700,300		)	(118,800		)
Eurodollar futures	(2,769,000		)	4,134,000		(4,838,000		)	(3,473,000		)
Options on U.S. Treasury futures	28,000			91,000		(114,000		)	5,000
Swaptions	159,000			—		(5,000		)	154,000
Interest rate swaps	10,000			5,000		—			15,000

The following tables present the components of realized and unrealized gains and losses related to our derivative instruments that were not designated as hedging instruments included in other income category in our condensed consolidated statements of operations for the three and nine months ended September 30, 2017 and 2016 (dollar amounts in thousands):



	Three Months Ended September 30,
	2017						2016
	Realized Gains (Losses)			Unrealized Gains (Losses)			Realized Gains (Losses)			Unrealized Gains (Losses)
TBA securities	$	1,470		$	(265	)	$	4,981		$	(2,547	)
Eurodollar futures ⁽¹⁾	62			39			(1,674		)	3,877
Interest rate swaps	—			36			—			65
Swaptions	—			171			—			190
U.S. Treasury and interest rate swap futures and options	(583		)	505			462			(790		)
Total	$	949		$	486		$	3,769		$	795



	Nine Months Ended September 30,
	2017						2016
	Realized Gains (Losses)			Unrealized Gains (Losses)			Realized Gains (Losses)			Unrealized Gains (Losses)
TBA securities	$	3,285		$	(1,080	)	$	13,489		$	883
Eurodollar futures ⁽¹⁾	849			(886		)	(3,180		)	547
Interest rate swaps	—			110			—			40
Swaptions	—			239			—			212
U.S. Treasury and interest rate swap futures and options	(999		)	699			(2,534		)	(1,251		)
Total	$	3,135		$	(918	)	$	7,775		$	431


⁽¹⁾	At September 30, 2017, the Eurodollar futures consist of 1,640 contracts with expiration dates ranging between December 2017 and June 2019.

The use of TBAs exposes the Company to market value risk, as the market value of the securities that the Company is required to purchase pursuant to a TBA transaction may increase or decrease from the agreed-upon purchase price. At September 30, 2017 and December 31, 2016, our condensed consolidated balance sheets include TBA-related liabilities of $181.7 million and $148.0 million included in payable for securities purchased, respectively. Open TBA purchases and sales involving the same counterparty, same underlying deliverable and the same settlement date are reflected in our condensed consolidated financial statements on a net basis. There were no TBA sales netted against TBA purchases at September 30, 2017. There was $114.4 million netting of TBA sales against TBA purchases of $262.4 million at December 31, 2016.

Derivatives Designated as Hedging Instruments

The Company’s interest rate swaps, except interest swaps included in its Agency IO portfolio, are used to hedge the variable cash flows associated with borrowings made under our financing arrangements, including FHLBI advances until January 2016 when we repaid them, and are designated as cash flow hedges. There were no costs incurred at the inception of the Company's interest rate swaps, under which the Company agrees to pay a fixed rate of interest and receive a variable interest rate based on one month LIBOR, on the notional amount of the interest rate swaps.

The Company documents its risk-management policies, including objectives and strategies, as they relate to its hedging activities, and upon entering into hedging transactions, documents the relationship between the hedging instrument and the hedged liability contemporaneously. The Company assesses, both at inception of a hedge and on an on-going basis, whether or not the hedge is “highly effective” when using the matched term basis.

The Company discontinues hedge accounting on a prospective basis and recognizes changes in the fair value through earnings when: (i) it is determined that the derivative is no longer effective in offsetting cash flows of a hedged item (including forecasted transactions); (ii) it is no longer probable that the forecasted transaction will occur; or (iii) it is determined that designating the derivative as a hedge is no longer appropriate. The Company’s derivative instruments are carried on the Company’s balance sheets at fair value, as assets, if their fair value is positive, or as liabilities, if their fair value is negative. For the Company’s derivative instruments that are designated as “cash flow hedges,” changes in their fair value are recorded in accumulated other comprehensive income (loss), provided that the hedges are effective. A change in fair value for any ineffective amount of the Company’s derivative instruments would be recognized in earnings. The Company has not recognized any change in the value of its existing derivative instruments designated as cash flow hedges through earnings as a result of ineffectiveness of any of its hedges.

The following table presents the fair value of derivative instruments designated as hedging instruments and their location in the Company’s condensed consolidated balance sheets at September 30, 2017 and December 31, 2016, respectively (dollar amounts in thousands):



Derivatives Designated as Hedging Instruments	Balance Sheet Location	Total Notional Amount		September 30, 2017		December 31, 2016
Interest rate swaps	Derivative asset	$	80,000	$	18	$	—
Interest rate swaps	Derivative asset	65,000		—		108
Interest rate swaps	Derivative liabilities	150,000		—		6

The Company has netting arrangements by counterparty with respect to its interest rate swaps. There was no netting of interest rate swaps designated as hedging instruments at September 30, 2017.

The following table presents the impact of the Company’s derivative instruments on the Company’s accumulated other comprehensive income for the nine months ended September 30, 2017 and 2016, respectively (dollar amounts in thousands):



	Nine Months Ended September 30,
Derivatives Designated as Hedging Instruments	2017			2016
Accumulated other comprehensive income for derivative instruments:
Balance at beginning of the period	$	102		$	304
Unrealized loss on interest rate swaps	(84		)	(607		)
Balance at end of the period	$	18		$	(303	)

The Company estimates that over the next 12 months, approximately none of the net unrealized gains on the interest rate swaps will be reclassified from accumulated other comprehensive income (loss) into earnings.

The following table details the impact of the Company’s interest rate swaps designated as hedging instruments included in interest expense for the three and nine months ended September 30, 2017 and 2016, respectively (dollar amounts in thousands):



	Three Months Ended September 30,				Nine Months Ended September 30,
	2017		2016		2017		2016
Interest income-investment securities	$	176	$	—	$	249	$	—
Interest expense-investment securities	—		177		—		604

The following table presents information about our interest rate swaps (includes interest rate swaps in our Agency IO portfolio) whereby we receive floating rate payments in exchange for fixed rate payments as of September 30, 2017 and December 31, 2016, respectively (dollar amounts in thousands):



	September 30, 2017						December 31, 2016
Swap Maturities	Notional Amount		Weighted Average Fixed Interest Rate		Weighted Average Variable Interest Rate		Notional Amount		Weighted Average Fixed Interest Rate		Weighted Average Variable Interest Rate
2017	$	80,000	0.71	%	1.23	%	$	215,000	0.83	%	0.74	%
2019	10,000		2.25	%	1.32	%	10,000		2.25	%	0.97	%
Total	$	90,000	0.88	%	1.24	%	$	225,000	0.90	%	0.75	%

The following table presents information about our interest rate swaps in our Agency IO portfolio whereby we receive fixed rate payments in exchange for floating rate payments as of September 30, 2017 and December 31, 2016, respectively (dollar amounts in thousands):



	September 30, 2017						December 31, 2016
Swap Maturities	Notional Amount		Weighted Average Fixed Interest Rate		Weighted Average Variable Interest Rate		Notional Amount		Weighted Average Fixed Interest Rate		Weighted Average Variable Interest Rate
2026	$	5,000	1.80	%	1.33	%	$	5,000	1.80	%	1.00	%
Total	$	5,000	1.80	%	1.33	%	$	5,000	1.80	%	1.00	%

The use of derivatives exposes the Company to counterparty credit risks in the event of a default by a counterparty. If a counterparty defaults under the applicable derivative agreement, the Company may be unable to collect payments to which it is entitled under its derivative agreements and may have difficulty collecting the assets it pledged as collateral against such derivatives. The Company currently has in place with all counterparties bi-lateral margin agreements requiring a party to post collateral to the Company for any valuation deficit. This arrangement is intended to limit the Company’s exposure to losses in the event of a counterparty default.

The Company is required to pledge assets under a bi-lateral margin arrangement, including either cash or Agency RMBS, as collateral for its interest rate swaps, futures contracts and TBAs, whose collateral requirements vary by counterparty and change over time based on the market value, notional amount, and remaining term of the agreement. In the event the Company is unable to meet a margin call under one of its agreements, thereby causing an event of default or triggering an early termination event under one of its agreements, the counterparty to such agreement may have the option to terminate all of such counterparty’s outstanding transactions with the Company. In addition, under this scenario, any close-out amount due to the counterparty upon termination of the counterparty’s transactions would be immediately payable by the Company pursuant to the applicable agreement. The Company believes it was in compliance with all margin requirements under its agreements as of September 30, 2017 and December 31, 2016. The Company had $7.9 million and $6.1 million of restricted cash related to margin posted for its agreements as of September 30, 2017 and December 31, 2016, respectively. The restricted cash held by third parties is included in receivables and other assets in the accompanying condensed consolidated balance sheets.